Fipsfinancial Institutions Performance Survey

Financial Institutions Performance Survey FIPS December 2018 Quarterly Results 2 | KPMG | FIPS Quarterly Results December 2018 Overview

Capital On 26 February 2019, the RBNZ Various market participants have Deputy Governor, Geoff Bascand, published their own impact In our recent publication FIPS spoke at Victoria University in assessment of the proposed Banks: Review of 2018 released on Wellington, highlighting that capital changes, such as Harbour 12 February 20191, we discussed the “increasing the amount of capital Asset Management Partners6 and consultation paper released by the banks must have would help to Hobson Wealth7. A memo from the Reserve bank of New Zealand (RBNZ) improve the safety of New Zealand’s RBNZ to the government was also in December 2018 on capital required financial system and wellbeing” released where the RBNZ warned by registered banks in New Zealand, where the proposal aims to “make the government to expect intensive asking “how much capital is enough?”. bank failures less likely, ensure that lobbying from the big four banks8. This analysis looked at the RBNZ’s bank shareholders have a meaningful rationale behind the proposed changes With the consultation period ending interest in their bank’s business, and in the consultation, some of the on 3 May 2019, and a final decision are able to absorb a greater share of potential impacts on the banks and expected in the third quarter of 2019, any loss if they occur”2. the economy if these changes were this issue still has a while to run, with to be implemented, and some initial On the other hand, UBS released a no doubt more views and research to reactions from various participants to report on 1 March 2019, stating that be expressed from various parties. this consultation. it believes it is “highly unlikely” that Again, we reiterate the RBNZ’s desire the RBNZ will change its proposal These new proposed capital to hear from everyone in the economy in the consultation paper as a result requirements would drive up the as part of this consultation process, of the consultation period, and that minimum level of capital needing to as part of this process is reviewing the economic impact from these be held to up to 16%, and reduce the the credit appetite of the community, changes will be greater than the amount of ‘lower’ types of capital and the effects of these proposed impact assumed by the RBNZ. The that can be used. As can be seen capital changes will impact the wider RBNZ is expecting that banks’ net on page 10, some banks will require economy, not just the banks. interest margins (NIM) will need to significantly higher amounts of capital increase by approximately 20-40 basis to meet these new requirements, points (bps) as a result of the capital Tax Working Group final especially when you note that the changes, whereas UBS expects that report figures on page 10 include tier two and mortgage rates will at least need to types of tier one capital that may no On 21 February 2019, after many rise by between 38 – 75 bps (a rate longer be permissible capital under the months of speculation and debate, the which assumes the RBNZ’s lower proposed changes. Tax Working Group (TWG) issued its implied return on equity target for much anticipated final report Future Some of the key possible impacts banks, as a result of the bank being of Tax: Final Report 9. In the final from these changes were lower rates greater capitalised and thus a ‘safer report, the TWG presented various on deposits; higher rates on lending; investment’)3. Previous estimates from recommendations on different areas of a possible reduction of available credit UBS have estimated the impact on taxation, such as businesses, savings in the economy, particularly in certain borrowers to be an increase in rates and personal income. However, the industries; and lower shares prices paid on lending by up to 125 bps4. biggest area of interest for many was of banks (with flow on impacts to Further to this, on 6 March 2019, an ex- the recommendations regarding the KiwiSaver funds that invest in banks) central bank official said he expected taxing of capital gains. than before. that the proposed capital changes will Since FIPS Banks: Review of 2018 cost the New Zealand economy $1.5 The biggest area of interest for was released, further commentary – $2 billion a year, and will not actually many was the recommendations has been published from various make the banks much safer. He also regarding the taxing of participants, from both angles of alleges the RBNZ set the proposed capital gains. providing further rationale for the risk profile of banks in the consultation proposed changes (from the RBNZ) paper, being a one in a two hundred and possible impact estimates from year event, to reach a pre-determined other market observers. outcome of increasing bank capital, where a one in a one hundred year event would not require the banks to hold additional capital5.

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The members of the TWG reached The proposals and recommendations The ‘remit’ replaces the Policy Targets consensus that there “should be from the TWG are neither final nor Agreement (PTA) that has historically an extension of the taxation of binding on the government. The been in place between the Minister capital gains from residential rental government coalition partners will of Finance and the RBNZ Governor, investment properties”; however, take on board the recommendations with the MPC making monetary policy only eight of the eleven members of put forward and will present a decisions under the transparency the TWG support the introduction of proposed tax reform package in April requirements and decision-making “a broad approach to the taxation of 2019. However, it is expected that procedures set out in the ‘charter’. capital gains… a realisation-based implementation of any new tax would These rules and agreements come tax that is applied to capital gains not come into force until 2021, or into force from 1 April 2019. on a broad range of assets, at full possibly 2022 (after the next general The ‘remit’ agreed set monetary policy rates, with no allowance for inflation”. election, to be held in 2020). As such, objectives of the following areas: The difference in view on this matter the next general election is likely to derived from the belief in whether the also be a referendum on the country’s –– Keep inflation between one and benefits gained from this broader tax support of the proposed tax reform three percent over the medium approach would offset the costs and package. It will be interesting to see term, with a focus on keeping any inefficiency created. what the differences are between inflation near the two percent mid- the TWG recommendations and the point; and Other areas of focus in the final report final proposed tax reform package, as concentrated on the following topics: –– Support maximum sustainable certain areas of the recommendations employment. –– encouraging environmental and (such as the impacts on small ecological outcomes; businesses and farming) have These objectives are in line with the previous PTA. –– simplifying business tax; become hotly debated and potentially could sway key voting blocks in the –– buildings and housing; While the ‘remit’ is largely in line with next election. the previous PTA, one of the bigger –– encouraging retirement savings; changes is the inclusion of non-RBNZ and For a more comprehensive analysis of what the TWG recommended in staff on the MPC. The MPC will –– progressivity in the income tax. its final report on 21 February 2019, consist of between five and seven Reactions to the recommendations KPMG’s summary of, and initial views members where the majority is made from the TWG’s final report have been on, the TWG’s final report can be up of RBNZ staff. Previously the RBNZ both extreme and varied, with many found at the following link: https:// committee that made monetary policy supporters and detractors on both assets.kpmg/content/dam/kpmg/nz/ decisions was solely made up of sides of the political spectrum. For pdf/February/tax-working-group-final- RBNZ staff. instance, the leader of the Opposition, report.pdf. One concern regarding non-RBNZ Simon Bridges, called the capital gain staff being included in these meetings tax recommendations “an attack on New RBNZ monetary was the risk that RBNZ decisions the Kiwi way of life”10, while Finance were influenced by the political Minister Grant Robertson hit back policy committee remit party in power, as the Minister at capital gain tax critics saying On 14 February 2019, Finance of Finance appointed the MPC “it’s change and change is always Minister Grant Robertson and RBNZ members based on the RBNZ Board’s challenging for people” and “it’s a Governor Adrian Orr signed both recommendations. However, with the different type of tax and I’m not sure the first ‘remit’ which sets out the majority of MPC being RBNZ staff that is something that people have got RBNZ’s dual employment and price and with decisions being made by their head around yet”11. stability objectives, and the ‘charter’ that will govern the decision making the majority, this step is likely to help of the RBNZ’s new Monetary safeguard the independence of the Policy Committee (MPC). These are RBNZ’s decisions from politics. changes and actions that arose from the Phase 1 review of the Reserve Bank Act12.

Where consensus is not reached, First home buyers also accounted for those making decisions in the MPC After a period of relative calm, the 9.43% of new mortgage borrowers will have meeting minutes noting competition for mortgages appears in January 2019, up from 7.52% in where differences exist and the to have heated up. January 2018, and in value terms balance of votes where consensus accounting for 17.28% of total new is not reached. These notes will be mortgage lending in January 2019, interesting to follow, especially to see TSB is also looking to more overtly up from 15.26% a year earlier17. This whether non-consensus decisions compete with the big Australian banks, trend shows that the amount being become split across internal and offering to match any one-year home borrowed is still relatively stable, external divides. loan rate advertised by the Australian while they are doing more of the banks and encouraging customers to overall borrowing; such a trend also While these changes seem relatively keep their loans in New Zealand so the starts to indicate fairly stable, or small and procedural, this aspect customers’ bank’s profits can benefit slightly dropping, house prices, with is just the first implementation of the local economy15. less competition from other buyers the Phase 1 review of the Reserve (borrowers). Bank Act; however, this change is With this recent spike in competitive just the first of several changes as rates being offered after a period of Interestingly, lending to investors a result of both this review, and relative calm, customers are benefiting in the month of January 2019, by the Phase 2 review commenced in from a long period of low interest numbers and value, both dropped November 2018. Phase 2 is likely rates. However, possibly due to the compared to lending in January 2018, to result in some more significant low interest rates, more households down 10.43% to 2,309 borrowers areas, such as consideration of are having debt secured against their and down 6.80% to $726 million of deposit insurance, separation of the house, with only one third of homes lending. There are various reasons prudential supervision responsibilities being mortgage free. The percentage that could be impacting these figures, of the RBNZ, and what is ‘in’ of homeowners over 65 (retirement with the most likely scenario being a and ‘out’ of the RBNZ prudential age) who have no mortgage on their combination of factors. These are the regulation responsibility13. home has dropped from 78% in foreign buyer bans that commenced the mid 2000’s to a 72% average in October 2018, possible changes in Lending and housing between 2015 and 2017, and the latest capital gains tax, and new anti-money laundering rules that have been in After a period of relative calm, the household expenditure survey shows place since 1 January 2019, where competition for mortgages appears to only 38% of people between the ages 16 real estate agents are now required to have heated up, with HSBC dropping of 55-64 own freehold homes . investigate sources of funding in order their two year mortgage rate to just to prevent illegal money being used to 3.69%. This rate is 50 bps lower New mortgage lending in January purchase property in New Zealand18. than Kiwibank which has the next was up 9.6% to $4.05 billion from lowest rate for the two-year term at January 2018. Based on lending data from January the time of the announcement. The 2019, it appears that first home ’Premier‘ special is the lowest-ever buyers were able to make the most fixed home loan rate from any bank of some of this relaxation. First home New mortgage lending in January was to be offered in New Zealand in the borrowers with higher than 80% up 9.6% to $4.05 billion from January last fifty years. However, this rate loan-to-value ratios (LVRs) increased 2018, while the number of new is only available to existing premier by 78.59% to 634 borrowers, and borrowers only increased by 0.94% to customers who borrow an additional lending increased as well, up 91.78% 18,774, moving the average mortgage $100,000, or new premier customers to $134 million of lending, bringing lending per borrower up to $215,777 who take out a combined home loan the average new mortgage lent to for January 2019 from $198,710 in of at least $500,000 or put $100,000 first home buyers to $441,640 in January 2018. First home buyers into savings and investments in HSBC January 2019, up from $411,267 in increased the most of all groups, New Zealand14. HSBC NZ’s CEO January 2018. rising 26.68% to 1,771 borrowers explained the campaign is aiming and increasing lending by 24.11% to to stimulate demand in a softening $700 million in January, while their market following the house prices average borrowing decreased from decreasing in Sydney and Melbourne. $403,433 to $395,257.

Owner occupiers with over 80% Looking at property sales, the driver Analysis of results LVRs also saw increases in both the of mortgage lending, Barfoot & We have presented our analysis of number of borrowers (23.94%) and Thompson’s sales for February 2019 the results for the quarter ended value of lending (46.00%), bringing were down 29% from February last 31 December 2018 on pages 6 to 14. their average lending from $303,030 year, dropping to 474 sold properties, The highlights from this analysis are to $356,968. However, the amount and the lowest since the global that net profit has dropped by 10.36% lent to first home buyers with LVR financial crisis in December 2008. ($154 million) to $1,335 million, off above 80% was 40% of total lending Barfoot and Thompson also noted that the back of a 4.59% increase in the to first home buyers for the month, the market appeared to be shifting September 2018 quarter and a 14.59% and the amount lent to existing owner in the buyer’s favour; however, more increase in the June 2018 quarter. This occupiers with LVR above 80% was vendors have been choosing to take result has been driven by a decrease just 5.66% of total lending to existing their properties off the market rather in non-interest income of $214 million, owner occupiers for the month. than reducing their price expectations. a decrease in impaired asset expense The true test of the market will be For first home buyers, borrowing of $102 million, and a slight dip in based on how many people can $400,000 is quite a large amount, operating expenses of $7 million choose to do withdraw their property assuming a 20% ($100,000) deposit, partially offset by an increase in from the market, and how long they when the average annual household interest income of $86 million can do it for, before they need to sell. income before tax was $105,719 and a reduction in tax expense of Barfoot & Thompson also noted the for the year ended June 201819. $83 million. median selling price has decreased, Combined with the considerable dropping 3.2% from $827,500 in Loan growth has continued its path of cost of living, especially in Auckland February 2018 to $801,000 this year; steady modest increases. Kiwibank where the average house price is while the number of new listings saw strong growth in the quarter, $800,00020 and would require a plummeted, dropping 10.5%, the up 2.93%, while Heartland had a $160,000 deposit (20%), more and lowest for the month since February significant drop of 14.95%, a drop more New Zealanders are using their 201222. However, 1,563 properties driven by the transfer of its Australian KiwiSaver funds to finance their first were listed in the month of February operations out of the New Zealand home. First home withdrawals from 2019 and still had 4,600 properties registered bank into the ultimate KiwiSaver in January 2019 increased by available for sale at the end of February holding company. For the year-to-date, 6.5% to $59.4 million when compared 2019, thus showing that many sellers TSB continues to be the strongest to those of the previous January21. are still looking for buyers. The performer of all the banks, with growth New homeowners borrowed a decrease in property values seen by of 9.71%; however, this quarter’s combined total of $700 million this Barfoot and Thompson is supported performance has boosted Kiwibank month, with an implied deposit by Quotable Value figures, showing into the top three year-to-date for of $175 million (conservatively a 0.9% dip in the average property loan growth. Of the major four banks, assuming 20% deposit), suggesting value in Auckland for February 2019 CBA saw the strongest growth in the at least approximately 33.94% of this compared to that of February 2018, quarter of 1.76%, while Westpac had amount is being met with KiwiSaver thus becoming the third consecutive the lowest growth of 0.68%. funds. This trend is possibly due to drop in values23. New Zealanders feeling as if digging Asset quality has slightly worsened into their retirement funds is the over the quarter, albeit off a very low only way to get on to the property base. Impaired asset expense is up ladder, but this feeling and impact is $102 million; but this is an increase far from limited to first home buyers, from a recovery of $22 million in the as more people at retirement age are prior quarter to an impairment expense still paying off their mortgages, as of $80 million in the current quarter. noted earlier. Provision levels continue to remain fairly low and stable, with a small drop in individually assessed provisions and a small increase in collectively assessed provisions.

Movement in net profit

$MILLION 1,800

1,600 Net interest income 1,400 $1,489M +$86M 3.42% -$214M +$7M $1,335M 1,200 +$102M -$83M to $2,613 million 1,000

800

Net interest margin 600 Driven by 400 Westpac 20 bps 200 0 ANZ 10 bps SEP 2018 NET NON- OPERATING IMPAIRED TAX DEC 2018 NPAT INTEREST INTEREST EXPENSES ASSET EXPENSE NPAT BNZ 10 bps INCOME INCOME EXPENSES

TABLE 1: Movement in interest margin

31 Dec 18 Mvmt. Mvmt. Mvmt. quarter during for the 6 for ended the months the 12 (%)26 quarter (bps) months Non-interest (bps) (bps) income

ANZ 2.2% 10 0 1

BNZ 2.2% 10 10 10

CBA 2.0% 0 -10 -4 Heartland Bank 4.3% -10 -10 -7 Driven by Kiwibank 2.1% -10 -10 5 ANZ -$119M SBS Bank 2.5% -10 -10 -18 The Co-operative BNZ -$70M Bank 2.3% -10 -10 1 Westpac TSB Bank 1.9% 0 10 10 -$43M Westpac 2.3% 20 20 34

10.36% to $1,335 million

$MILLION 1,800 1,600 Impaired 1,400 $1,489M +$86M asset -$214M +$7M $1,335M expenses 462.9% 1,200 +$102M -$83M up $102 million 1,000

800

600 400 Driven by

200 ANZ $36M

0 Westpac $28M SEP 2018 NET NON- OPERATING IMPAIRED TAX DEC 2018 NPAT INTEREST INTEREST EXPENSES ASSET EXPENSE NPAT INCOME INCOME EXPENSES CBA $25M

Operating 25.13% expenses 0.56% down $214 million up $7 million

Driven by

-$119M Westpac $9M -$70M CBA $8M -$43M ANZ -$11M

TABLE 2: Analysis of gross loans

31 Dec 18 30 Sep 18 quarter quarter % Quarterly analysis ended ended Increase $Million $Million Loans 1.16% ANZ 130,542 129,194 1.04% BNZ 85,022 83,800 1.46% to $420,860 million CBA 88,525 86,990 1.76% Heartland Bank 3,521 4,140 -14.95% Kiwibank 19,428 18,874 2.93% SBS Bank 3,963 3,878 2.20% Quarterly The Co-operative Bank 2,441 2,390 2.17% TSB Bank 5,685 5,579 1.88% Kiwibank 2.93% Westpac 81,734 81,184 0.68% Total 420,860 416,028 1.16% SBS Bank 2.20% 31 Dec 18 31 Dec 17 quarter quarter % Annual analysis Heartland ended ended Increase 14.95% $Million $Million ANZ 130,542 125,803 3.77% Year on year BNZ 85,022 80,408 5.74% CBA 88,525 83,801 5.64% TSB 9.71% Heartland Bank 3,521 3,815 -7.71% Kiwibank 19,428 18,065 7.54% The Co-operative SBS Bank 3,963 3,782 4.77% Bank 7.56% The Co-operative Bank 2,441 2,270 7.56% TSB Bank 5,685 5,181 9.71% Kiwibank 7.54% Westpac 81,734 78,527 4.08% Total 420,860 401,652 4.78%

1 NEW MORTGAGE LENDING BY BORROWER TYPE 2 NEW MORTGAGE LENDING BY PAYMENT TYPE

$MILLION % $MILLION % 20,000 26 20,000 42

16,000 24 16,000 40

12,000 22 12,000 38

8,000 20 8,000 36

4,000 18 4,000 34

0 16 0 32 DEC 16 JUN 17 DEC 17 JUN 18 DEC 18 DEC 16 JUN 17 DEC 17 JUN 18 DEC 18

FIRST HOME BUYER (LHS) BUSINESS PURPOSES (LHS) INTEREST ONLY (INCLUDING REVOLVING CREDIT) (LHS) OTHER OWNER OCCUPIER (LHS) INVESTOR LENDING (%) (RHS) PRINCIPAL AND INTEREST (LHS) INVESTOR (LHS) PROPORTION OF NEW LENDING INTEREST ONLY–INVESTOR (%) (RHS)

SOURCE: RESERVE BANK OF NEW ZEALAND STATISTICS SOURCE: RESERVE BANK OF NEW ZEALAND STATISTICS

3 MOVEMENT IN PROVISIONING $BILLION % Individually 2.5 1.25 assessed 4.61% 2.0 1.00 provisions down $15 million 1.5 0.75

1.0 0.50 Driven by 0.5 0.25 ANZ $16M 0.0 0.00 DEC 12 DEC 13 DEC 14 DEC 15 DEC 16 DEC 17 DEC 18 CBA $12M COLLECTIVE PROVISION (LHS)

INDIVIDUAL PROVISION (LHS) TOTAL PROVISION FOR DOUBTFUL DEBTS/ GROSS LOANS AND ADVANCES (RHS)

Collectively TABLE 3: Movement in impaired asset expense/ Average gross loans assessed 2.47% 31 Dec 18 Movement Movement provisions quarter during the for the up $40 million ended (%) quarter 12 months (bps) (bps) ANZ 0.04% 11 0 Driven by BNZ 0.06% 3 5 CBA 0.16% 11 4 Westpac $35M Heartland Bank 0.79% 18 22 Kiwibank 0.07% 6 29 SBS Bank 0.38% -2 -7 Heartland $7M The Co-operative Bank 0.13% -2 2 TSB Bank -0.16% -26 -26 ANZ $12M Westpac 0.03% 17 0 Average 0.08% 10 3

4 MAJOR BANKS: PAST DUE AND GROSS IMPAIRED ASSETS VS. GROSS LOANS AND ADVANCES % % 1.0 300

0.8 240

GROSS IMPAIRED/ 0.6 180 GROSS LOANS AND ADVANCES (LHS) PAST DUE/GROSS 0.4 120 LOANS AND ADVANCES (LHS) TOTAL PROVISIONS/ 0.2 60 PAST DUE AND GROSS IMPAIRED ASSETS (RHS) 0.0 0

7 7

1 1

31 DEC

31 DEC 31 DEC

31 DEC

31 DEC 16

30 JUN

30 JUN ANZ BNZCBA KIWIBANKWESTPAC

Size & strength measures Profitability measures Entity Entity 31 Mar 17 30 Jun 17 30 Sep 17 31 Dec 17 31 Mar 18 30 Jun 18 30 Sep 18 31 Dec 18 31 Mar 17 30 Jun 17 30 Sep 17 31 Dec 17 31 Mar 18 30 Jun 18 30 Sep 18 31 Dec 18

Total assets25 ($Million) Interest margin26 (%) ANZ 161,007 164,071 158,185 160,583 159,719 164,588 161,416 164,698 ANZ 2.14 2.14 2.18 2.19 2.20 2.20 2.10 2.20 BNZ 94,023 95,324 95,315 97,742 97,065 101,678 99,991 102,536 BNZ 1.98 2.06 2.21 2.10 2.20 2.10 2.10 2.20 CBA 92,077 92,828 92,801 97,762 98,643 101,338 101,906 103,157 CBA 1.91 1.92 1.99 2.04 2.00 2.10 2.00 2.00 Heartland Bank 3,896 4,035 4,222 4,307 4,388 4,496 4,596 4,018 Heartland Bank 4.35 4.54 4.49 4.37 4.50 4.40 4.40 4.30 Kiwibank 20,428 20,616 20,449 20,381 20,498 20,715 20,935 22,040 Kiwibank 1.82 1.95 1.95 2.05 2.10 2.20 2.20 2.10 SBS Bank 3,994 4,060 4,237 4,347 4,455 4,501 4,574 4,660 SBS Bank 2.38 2.43 2.52 2.68 2.60 2.60 2.60 2.50 The Co-operative Bank 2,364 2,449 2,527 2,589 2,629 2,661 2,697 2,786 The Co-operative Bank 2.25 2.22 2.24 2.29 2.30 2.40 2.40 2.30 TSB Bank 6,803 6,958 7,072 7,278 7,416 7,454 7,527 7,733 TSB Bank 1.80 1.82 1.84 1.80 1.80 1.80 1.90 1.90 Westpac 92,533 94,215 95,666 96,041 96,216 98,438 96,656 98,537 Westpac 1.86 2.03 2.16 1.96 2.20 2.10 2.10 2.30 Total 477,125 484,555 480,474 491,031 491,030 505,868 500,298 510,164 Increase in Gross Loans and Advances (%) Non-interest income/Total assets25 (%) ANZ 0.90 0.93 0.64 0.36 0.82 1.69 0.17 1.04 ANZ 0.62 0.45 0.72 0.82 0.62 0.64 0.76 0.46 BNZ 1. 19 1.86 1.68 0.63 0.51 2.01 1.64 1.46 BNZ 0.35 0.74 0.54 0.65 0.63 0.55 0.64 0.36 CBA 1.06 1.37 0.82 1.93 0.97 1.68 1. 11 1. 76 CBA 0.63 0.61 0.64 0.64 0.62 0.67 0.63 0.71 Heartland Bank 3.62 2.64 3.78 2.81 2.48 2.69 3.12 -14.95 Heartland Bank 0.37 0.30 0.18 0.39 0.32 0.67 0.27 0.23 Kiwibank 2.25 -0.08 0.21 0.96 1. 01 0.93 2.49 2.93 Kiwibank 0.51 0.66 0.58 0.69 0.99 1. 14 0.98 0.91 SBS Bank 5.10 3.45 4.53 2.07 1. 11 1.02 0.37 2.20 SBS Bank 0.79 0.77 0.78 0.85 0.85 0.82 0.88 0.92 The Co-operative Bank 3.00 3.25 2.00 2.26 1.21 1.51 2.48 2.17 The Co-operative Bank 0.58 0.95 0.84 0.89 0.67 0.71 0.63 0.69 TSB Bank 4.79 2.97 4.16 3.21 2.95 2.66 1.88 1.88 TSB Bank 0.21 0.25 0.79 0.29 0.71 0.28 0.35 0.33 Westpac 1.03 0.69 0.20 0.64 1.79 0.89 0.67 0.68 Westpac 0.68 0.73 0.57 0.78 0.48 0.74 0.60 0.43 Average 1.19 1.18 0.89 0.90 1.04 1.58 0.93 1.16 Average 0.57 0.60 0.63 0.73 0.61 0.66 0.68 0.50 Capital adequacy (%) Impaired asset expense/Average gross loans and advances (%) ANZ24 14.50 14.20 14.80 15.10 14.40 14.80 14.40 15.20 ANZ 0.01 0.04 0.03 0.04 0.19 0.02 -0.07 0.04 BNZ 13.29 12.79 13.32 13.47 13.10 13.20 13.60 13.30 BNZ 0.12 -0.01 0.21 0.01 0.20 0.14 0.03 0.06 CBA24 13.80 14.20 14.10 14.80 13.60 13.90 13.90 14.80 CBA 0.05 0.06 -0.08 0.12 0.16 0.06 0.05 0.16 Heartland Bank 13.19 13.56 13.04 14.76 14.10 14.10 13.40 13.30 Heartland Bank 0.46 0.47 0.56 0.57 0.60 0.60 0.61 0.79 Kiwibank 13.50 13.40 16.00 15.00 15.40 15.80 15.70 15.30 Kiwibank 0.05 -0.13 0.25 -0.22 0.03 -0.04 0.01 0.07 SBS Bank 12.56 11.91 11.35 11.80 12.80 13.00 13.10 14.10 SBS Bank 0.33 0.30 0.32 0.45 0.55 0.40 0.40 0.38 The Co-operative Bank 16.90 16.60 16.60 16.70 16.80 16.70 17.20 17.20 The Co-operative Bank 0.11 0.11 0.10 0.11 0.12 0.17 0.15 0.13 TSB Bank 14.60 14.85 14.55 14.54 14.30 14.70 14.50 14.80 TSB Bank 0.06 0.08 0.06 0.10 0.08 -0.01 0.10 -0.16 Westpac24 14.00 14.00 14.80 14.30 16.60 1 7. 1 0 16.60 16.90 Westpac 0.01 -0.07 -0.14 0.03 0.10 -0.01 -0.14 0.03 Average 0.05 0.01 0.03 0.05 0.17 0.05 -0.02 0.08 Net profit ($Million) Operating expenses/Operating income (%) ANZ 466 406 505 520 444 492 530 456 ANZ 35.67 39.28 34.30 34.46 35.08 35.28 35.64 38.14 BNZ 193 276 245 275 215 250 289 253 BNZ 42.91 38.65 37.99 38.69 46.85 40.48 37.85 40.42 CBA 255 248 292 275 264 296 297 292 CBA 36.25 38.02 35.00 35.19 37.05 37.20 35.39 35.22 Heartland Bank 16 16 16 15 18 19 17 13 Heartland Bank 41.23 42.93 43.70 44.54 39.76 41.07 41.60 47.60 Kiwibank 22 -32 14 28 33 39 32 30 Kiwibank 73.04 138.17 78.74 79.41 69.43 69.20 72.87 71.71 SBS Bank 6 7 6 7 7 8 8 8 SBS Bank 62.36 60.78 67.09 64.26 61.60 61.38 60.91 62.97 The Co-operative Bank 2 3 3 3 1 3 3 3 The Co-operative Bank 79.33 76.96 74.55 73.32 86.39 76.50 75.00 76.33 TSB Bank 5 11 17 10 14 14 13 13 TSB Bank 77.37 55.00 47.54 59.48 53.44 50.77 53.75 60.63 Westpac 237 255 282 268 246 305 299 266 Westpac 42.26 43.81 40.03 40.00 39.29 36.77 38.26 39.89 Total 1,202 1,190 1,380 1,401 1,242 1,423 1,489 1,335 Average 40.92 44.82 38.96 39.34 41.20 39.46 39.15 40.91

$MILLION 5 MAJOR BANKS: NET PROFIT 600

500

400

300

ANZ 200 BNZ

CBA 100

KIWIBANK 0 WESTPAC -100 MAR 17 JUN 17 SEP 17 DEC 17 MAR 18 JUN 18 SEP 18 DEC 18

% MAJOR BANKS: INTEREST 6 MARGIN 2.40

2.30

2.20

2.10

ANZ 2.00 BNZ

CBA 1.90

KIWIBANK 1.80 WESTPAC 1.70 MAR 17 JUN 17 SEP 17 DEC 17 MAR 18 JUN 18 SEP 18 DEC 18

MAJOR BANKS: INCREASE % 7 IN GROSS LOANS AND 3.50 ADVANCES 3.00

2.50

2.00

1.50 ANZ

BNZ 1.00

CBA 0.50 KIWIBANK 0.00 WESTPAC -0.50 MAR 17 JUN 17 SEP 17 DEC 17 MAR 18 JUN 18 SEP 18 DEC 18

MAJOR BANKS: % 8 NON-INTEREST INCOME/ 1.20 TOTAL ASSETS

1.00

0.80

0.60 ANZ

BNZ 0.40 CBA

KIWIBANK 0.20 WESTPAC 0.00 MAR 17 JUN 17 SEP 17 DEC 17 MAR 18 JUN 18 SEP 18 DEC 18

MAJOR BANKS: % 9 OPERATING EXPENSES/ 150 OPERATING INCOME

130

110

90 ANZ

BNZ 70 CBA

KIWIBANK 50 WESTPAC 30 MAR 17 JUN 17 SEP 17 DEC 17 MAR 18 JUN 18 SEP 18 DEC 18

MAJOR BANKS: IMPAIRED % 10 ASSET EXPENSE/AVERAGE 0.30 GROSS LOANS AND ADVANCES

0.20

0.10

0.00 ANZ

BNZ -0.10 CBA

KIWIBANK -0.20 WESTPAC -0.30 MAR 17 JUN 17 SEP 17 DEC 17 MAR 18 JUN 18 SEP 18 DEC 18

MAJOR BANKS: GROSS % 11 IMPAIRED VS. IMPAIRED 0.50 ASSET EXPENSE

0.40

0.30

0.20

0.10 GROSS IMPAIRED LOANS/ GROSS LOANS AND ADVANCES 0.00 IMPAIRED ASSET EXPENSE/ AVERAGE GROSS LOANS AND ADVANCES -0.10 MAR 17 JUN 17 SEP 17 DEC 17 MAR 18 JUN 18 SEP 18 DEC 18

MAJOR BANKS: INTEREST $BILLION $BILLION 12 EARNING ASSETS 6.0 500 COMPARED TO INTEREST INCOME AND EXPENSE 5.0 475

4.0 450

3.0 425

INTEREST INCOME (LHS) 2.0 400 INTEREST EXPENSE (LHS)

NET PROFIT (LHS) 1.0 375

TOTAL ASSETS (RHS) 0.0 350 DEC 14 JUN 15 DEC 15 JUN 16 DEC 16 JUN 17 DEC 17 JUN 18 DEC 18

$MILLION % 13 LVR ANALYSIS OF RESIDENTIAL MORTGAGES 25,000 100

20,000 96

15,000 92

10,000 88

NEW MORTGAGES (LHS) 5,000 84 PROPORTION OF NEW MORTGAGES WITH LVR OF 80% OR BELOW (RHS) 0 80 SOURCE: RESERVE BANK OF NEW ZEALAND STATISTICS SEP 16 DEC 16 MAR 17 JUN 17 SEP 17 DEC 17 MAR 18 JUN 18 SEP 18 DEC 18

Introduction AI in the financial sector AI is at the forefront of an The financial sector is leading the adoption of AI-driven decision-making information revolution that by improving customer experience is fundamentally reshaping via the use of virtual assistants how we think, create, explore and chatbots. AI technology is also being deployed to reduce risk and make decisions. AI is through the automated detection of a collection of advanced fraudulent activity, money laundering transactions, operating costs technologies that allows and errors through the intelligent machines to sense, discover, automation of back-end business comprehend, reason, act and processes28. AI has increased the speed and accuracy of decision- learn. These technologies making, and reduced the time spent enable a diverse range of on false-positives. Instead of replacing Dr Stephen Hastings advanced methodologies that humans, AI-enabled systems are alleviating time pressures and allowing Partner include pattern recognition, human workers to focus on higher KPMG Lighthouse machine learning, natural priority cases. language processing, Steve has recently joined KPMG intelligent automation and Instead of replacing humans, AI- New Zealand as a partner setting more. Global research firm enabled systems are alleviating up the new Lighthouse division – a time pressures and allowing CoE for data and analytics. Steve Gartner predicts that almost human workers to focus on higher is an advanced data and analytics all software developed by priority cases. consulting professional with over 2020 will include AI-enabled 15 years’ experience in the field. He has 27 previously worked at KPMG Sydney features . The implementation of machine as a director setting up their data and learning approaches has shown analytics practice. Throughout his potential for agreements to be career Steve has led large teams and reviewed in seconds as opposed to projects to deliver complex data and days. According to Emerj, the top analytics engagements covering all 7 banks in America have all embraced aspects of the data value chain from AI technology in their business data warehousing and engineering offerings and processes29. A leading through business intelligence American bank has developed reporting to advanced analytics/data software to analyse legal documents science and data strategy. Throughout and extract key points and clauses. his career Steve has successfully Machine learning algorithms have delivered many projects across many also been introduced to facilitate sectors, using a client’s data assets and expedite the approval of combined with analytical approaches, personal loans, credit cards and to answer their key business questions auto loans. In some cases, these surrounding: customer experience, risk automated systems have denied loan management, growth, cost efficiency applications based on poor credit and innovation. score. Consumers have a right to know and understand an algorithm’s decision-making process and rationale.

Traditionally, the cause of rejection Reliability and trust in AI is paramount made, the data used, the patterns is identified and reviewed with in building trust with customers detected, and the reasoning and the customer and, in some cases, and stakeholders; consumers are logic applied to reach a decision. reapproved30. This may not be the case increasingly demanding awareness Explainability helps to bridge with AI algorithms where the decision- of how their data is being utilised. consumer understanding and making processes are less transparent Constructing and deploying algorithms trust in AI systems. This includes and more difficult to interpret. in an ethical and responsible manner giving consideration to the trade-off Companies which deploy AI algorithms increases consumer trust. between algorithm interpretability to make business decisions need to and accuracy. More complex be able to explain their AI’s models, models (such as neural nets) which otherwise they cannot stand behind Governance and control over may produce greater accuracy the decisions. algorithms is critical. are more difficult to explain and interpret when compared with Algorithm assurance simple decision trees. As AI systems become more refined –– Transparency: Regardless of Governance and control over and generally applied, their impact on algorithms is critical as the pressure explainability, companies should individual lives and society at large be looking at increasing the mounts to deploy AI to remain will become increasingly profound. competitive. However, poorly designed transparency of their AI models. Any application and design of AI must This could include disclosing the algorithms (and potential biases in broadly consider the following: data) can produce inaccurate results data used to train these algorithms and misinformation, resulting in bad –– ‘Explainabilty’: AI systems (to ensure that it is balanced and decisions and reputational damage. should be sufficiently transparent representative), the types of Only 35% of executives trust the AI to understand how an algorithm algorithms and methods used, and that generate decisions31. arrives at a particular result. This the population/use-case that the includes detailing the assumptions algorithm can be applied to.

Building an environment that fosters greater AI control

–– Bias: AI systems should be free Auditing is essential for AI The key features of AI In Control are: from biases. Most of these biases to succeed are a result of poorly represented AI governance: or skewed data used to train an AI assurance requires robust governance and internal reviews –– Criteria for designing, building, algorithm, or algorithms being and continuous monitoring and applied to populations that are leveraging software development best practices, which includes control of AI solutions and their significantly different from those performance, without impeding that they were trained upon. comprehensive documentation, structured design processes, iterative innovation and flexibility. –– Accountability: Companies review and domain expertise. Good AI assessment: need to be clear and transparent AI assurance practices ultimately with regards to who ultimately increase consumer trust and –– Diagnostic reviews of Al solutions, carries responsibility for the algorithm reliability. and risk assessments of control outcomes resulting from the use of environments to determine Introduced by KPMG, ‘AI In Control’ is AI algorithms. organisational readiness for a framework supported by a global set effective Al control. Prototype AI models embedded of methods, tools and assessments into applications with inadequate that helps organisations realise the –– Methodologies and tools assurance and ethical controls greatly value of their AI technologies while to evaluate business-critical increases risk exposure. Faults in maintaining algorithm integrity. algorithms, putting testing controls data systems and applications may Through an evolutionary lifecycle in place, and overseeing design, be present due to biases in data, or this methodology helps increase implementation and operation of poor algorithm design. This can have reliability of these algorithms and Al programmes to help address profound implications on customer builds trust in both the insights and Al’s inherent challenges: integrity, experience, decision-making results produced33. explainability, fairness and agility. security, credibility, and ultimately consumer trust32. It is essential that a vigorous governance and control framework is in place to monitor these technologies. Only by establishing and adhering to a robust AI assurance model can we gain confidence in the way AI influences decision-making.

1 https://home.kpmg/nz/en/home/insights/2019/02/fips-banks--review- 20 https://www.reinz.co.nz/Media/Default/Statistic%20Documents/2019/ of-2018.html Residential/January/REINZ%20Monthly%20Property%20Report%20 2 https://www.rbnz.govt.nz/news/2019/02/safer-banks-for-greater- -%20January%202019.pdf wellbeing 21 https://www.interest.co.nz/opinion/98443/david-hargreaves-crunches- 3 https://www.interest.co.nz/banking/98370/ubs-banking-analysts- some-numbers-growing-proportion-first-home-buyers-uncertain suggest-aussie-banks-response-rbnzs-proposals-increase-bank 22 https://www.interest.co.nz/property/98438/barfoot-thomsons-february- 4 https://www.interest.co.nz/banking/97716/against-backdrop-rbnzs- sales-were-down-29-compared-year-ago review-bank-capital-requirements-gareth-vaughan-details-nitty 23 https://www.interest.co.nz/property/98469/qv-figures-show-average- 5 https://www.nzherald.co.nz/index.cfm?objectid=12209846&ref=twitter residential-property-value-auckland-has-declined-three 6 https://www.harbourasset.co.nz/research-and-commentary/australian- 24 The capital adequacy ratio’s reported are for the overseas banking group banks-increased-capital-requirements-to-change-the-landscape/ for quarters ended up to and including 31 December 2017. From 31 March 2018, the capital adequacy ratio reported reflects the ratio of 7 https://www.nzherald.co.nz/business/news/article.cfm?c_ the local registered banking group in line with the information disclosed id=3&objectid=12196283 in the RBNZ Dashboard. 8 http://www.scoop.co.nz/stories/PO1903/S00120/rbnz-warned-the-govt- 25 For quarters ended 31 December 2017 and earlier, total assets excluded of-intensive-lobbying-by-banks.htm intangible assets. From 31 March 2018, intangible assets are no longer 9 https://taxworkinggroup.govt.nz/resources/future-tax-final-report deducted as this information is not available in the RBNZ Dashboard. 10 https://www.newshub.co.nz/home/politics/2019/02/disappointing- 26 In line with the information disclosed in the RBNZ Dashboard, the net objections-to-capital-gains-tax-recommendation-voiced.html interest margin is disclosed to 1 decimal place from 31 March 2018 11 https://www.nzherald.co.nz/business/news/article.cfm?c_ onwards. As interest earning assets is not disclosed in the RBNZ id=3&objectid=12207101 Dashboard, average net interest margin cannot be calculated from 31 March 2018 onwards. 12 https://www.rbnz.govt.nz/news/2019/02/new-rbnz-monetary-policy- committee-remit-reiterates-focus-on-price-stability-and-employment 27 Gartner, “Gartner Says AI Technologies Will Be in Almost Every New Software Product by 2020,” 2017. [Online]. Available: Gartner Says AI 13 https://www.rbnz.govt.nz/news/2018/11/first-consultation-paper- Technologies Will Be in Almost Every New Software Product by 2020. released-for-phase-2-of-reserve-bank-act-review 28 K. Sennaar, “AI in Banking – An Analysis of America’s 7 Top Banks,” 2019. 14 https://www.interest.co.nz/personal-finance/98460/taking-advantage- [Online]. Available: https://emerj.com/ai-sector-overviews/ai-in-banking- low-wholesale-rates-hsbc-launches-very-low-two-year-home analysis/. 15 https://www.tsb.co.nz/loans/home-loans-mortgages/switch?utm_ 29 KPMG International, “The Guardians of Trust,” 2018. source=interest&utm_campaign=tsb_pricematchupweight_2019&utm_ content=970x250&dclid=CLnPlbGH7OACFcdGKwod6ZENew 30 S. Klous, “In AI we trust?,” 2019. [Online]. Available: https://home.kpmg/ xx/en/home/insights/2018/06/in-ai-we-trust.html. 16 https://www.nzherald.co.nz/business/news/article.cfm?c_ id=3&objectid=12209047 31 S. Maskey, “Forbes,” 12 05 2018. [Online]. Available: https://www.forbes. com/sites/forbestechcouncil/2018/12/05/how-artificial-intelligence-is- 17 https://www.rbnz.govt.nz/statistics/c31 helping-financial-institutions/. 18 https://www.justice.govt.nz/justice-sector-policy/key-initiatives/aml-cft/ 32 S. Malekar, “Medium,” 9 2018. [Online]. Available: https://medium.com/ info-for-businesses/real-estate-agents/ datadriveninvestor/ethics-of-using-ai-in-the-financial-banking-industry- 19 https://www.stats.govt.nz/information-releases/household-income-and- fa93203f6f25. housing-cost-statistics-year-ended-june-2018 33 S. Klaus, “KPMG Artificial Intelligence in Control,” 12 2018. [Online]. Available: https://home.kpmg/xx/en/home/insights/2018/12/kpmg- artificial-intelligence-in-control.html.

John Kensington Jamie Munro Head of Banking and Finance Partner – Head of Insurance +64 (09) 367 5866 +64 (09) 367 5829 [email protected] [email protected]

Ross Buckley Brent Manning Executive Chairman Partner – Audit +64 (09) 367 5344 +64 (04) 816 4513 [email protected] [email protected]

Godfrey Boyce Paul Herrod Chief Executive Officer Partner – Audit +64 (04) 816 4514 +64 (09) 367 5323 [email protected] [email protected]

Graeme Edwards Gary Ivory National Managing Partner – Audit Partner – Corporate Finance +64 (04) 816 4522 +64 (09) 367 5943 [email protected] [email protected]

Jack Carroll Ceri Horwill National Managing Partner – Advisory Partner – Advisory +64 (04) 816 4516 +64 (09) 367 5348 [email protected] [email protected]

Ross McKinley Mike Clarke National Managing Partner – Tax Partner – Head of IT Advisory +64 (09) 367 5904 +64 (09) 363 3507 [email protected] [email protected]

Kay Baldock Rachel Piper Partner – Head of Financial Services Partner – Tax +64 (09) 367 5316 +64 (09) 363 3525 [email protected] [email protected]

Matthew Prichard Bruce Bernacchi Partner – Head of Funds Management Partner – Tax +64 (09) 367 5846 +64 (09) 363 3288 [email protected] [email protected]

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